Weekly note (19/10) | Risks remain in focus for markets

It was a generally calmer week for global markets, which were looking rebase following last week's spike in volatility that precipitated heavy declines in equity markets. While measures of financial market volatility eased, investor sentiment remained constrained by the ongoing risk factors from increasing US interest rates, trade concerns and political and economic tensions in Europe.   

In the US, the focus was on the early stages of the corporate reporting season. Last week's scrutiny over corporate valuations makes this a particularly important period as markets look for confirmation that earnings growth can sustain elevated valuations. Overall, the headline detail appeared generally positive, highlighted by Netflix posting above-consensus earnings following strong subscription growth. The news was also positive in the financial sector, with better-than-expected results from the major banks; JP Morgan Chase, Morgan Stanley, Goldman Sachs', Wells Fargo and Citi, although Bank of America Merril Lynch disappointed on loan growth. Outside of financials, the main disappointments were from IBM and Walmart.

For Australia, the strong results posted by US banks had helped to put a floor under the heavy declines in the financial sector from last week, although the recovery was modest in that context. Across the week, the benchmark ASX200 index posted a solid rise, which was supported by the consumer sectors. 

More broadly, the major indices in Europe mostly saw modest weekly gains after declining sharply by more than 4% last week. In Asia, against the trend of less volatile global markets, China's major indices fell heavily again this week — despite a rebound on Friday — weighed by broader concerns over the growth outlook and financial stability. 

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In Australia, the focus this week was on the labour market. Firstly, the Reserve Bank of Australia's (RBA) Deputy Governor Guy Debelle delivered a speech titled 'The State of the Labour Market', where the commentary continued to reflect the RBA's upbeat assessment of conditions. 

In summary, the RBA expects employment growth to remain above average and run ahead of growth in the working-age population. Combined with its forecasts for above trend economic growth, it continues to expect a gradual erosion in 'spare capacity' (unemployed and underemployed workers) and, in turn, a gradual rise in wages growth, which would ultimately lift inflationary pressures. 

Secondly, Australia's latest employment data for the month of September were released during the week. While only 5,600 jobs were added in the month, below an expected addition of 15,000, the nation's unemployment rate fell to 5% on a seasonally adjusted basis — its lowest level in more than six years and therefore is our chart of the week.  

Chart of the Week

Historically, the RBA has estimated Australia's rate of full employment to be around 5%. In technical terms, this is referred to as the non-accelerating inflation rate of unemployment (NAIRU), which is the level of unemployment where wage and inflationary pressures generally remain stable. 

However, as outlined in our review of September's Labour Force Survey, the sharp fall in the unemployment rate is not likely to portend a faster rise in wages growth in the near term. Furthermore, recent global experiences would suggest that unemployment rates have had to decline well below previously estimated NAIRU's to stimulate wage pressures, so this could also be the case for Australia.  

The main event during the week from a global-macro perspective were the minutes from the US Federal Reserve's meeting in September, where it increased its benchmark interest rate by 25 basis points to a target of 2-2.25%. 

The key point from these minutes was that the Fed sees the need for further interest rate increases given strong economic growth and a tight labour market. Of note, Fed members had discussed the possibility of rates being increased temporarily to a 'modestly restrictive' level to reduce the risk of inflation running above its 2% target and to prevent imbalances to financial stability from building up. While support for this stance was not unanimous without clearer signs of an overrun in inflation, it appears that the Fed is set to maintain its path for tightening, which as implied by its 'dot plot' points to one further increase in December, followed by three increases in 2019.

In Europe, last week's optimism that a Brexit deal may be imminent seemed to fray given renewed uncertainty over negotiations regarding the Ireland-Northern Ireland border issue. UK Prime Minister Theresa May also said she would consider the possibility of extending the 'transition period' for "a matter of months" after Britain exits the European Union (EU) in March next year, but that would still need to be supported by the parliament. 

The greater risk to markets from Europe are the tensions between the EU and Italy over its budget. Italy released its budgetary plans for 2019, which would increase its deficit to 2.4% of GDP — a level 3-times above the 0.8% target mandated by the EU and agreed to by the previous government. European Central Bank President Mario Draghi warned that contravention of the target would "carry a high price" for the other eurozone economies.

Rounding out the global risk factors, China's GDP growth for the September quarter slowed to an annual pace of 6.5%, which was a touch softer than expected by markets (6.6%). Policymakers in China face a delicate balance between implementing stimulus measures to ward off moderating economic growth, with the impact of trade tensions yet to be fully reflected in the data, while at the same time managing risks to financial stability from earlier concerns over the quality of lending, particularly from the non-bank sector.   

  

Australia's unemployment rate falls to 5%: lowest in 6 years

Australia's Labour Force Survey for September showed the nation's headline unemployment rate fell to 5%, its lowest level since April 2012. Australia's level of full-employment has generally been regarded to be around 5%, although it is likely that the unemployment rate will need to decline further, and then remain there for wages growth to lift more strongly than it has, which would then flow-on to lifting inflationary pressures.

Labour Force Survey — September | By the numbers

• Employment increased by 5,600 in September, which was below the median market forecast for +15,000. August's initially reported gain of 44,000 was lifted a touch to 44,600

• The seasonally adjusted unemployment rate fell to 5.00% (market f/c was 5.3%) from the level in August at 5.27%

• Participation rate fell 0.24ppt to 65.44% (market f/c was for no change at 65.7%)

•  Total hours worked in September lifted 0.4% to 1.757bn hours (+1.9%Y/Y)

•  Underutilisation rate fell 0.2ppt to 13.3%, while the underemployment rate was steady at 8.3%  

*click to expand charts

Labour Force Survey — September | The details

On a compositional basis, the 5,600 addition to employment in September was split +20,300 to full-time and -14,700 to part-time. Employment growth remains solid at an annual pace of 2.27%, but it has been easing through 2018.

Consistent with the rise in employment and the decline in the unemployment rate, total hours worked lifted in September (+0.4%), with an annual increase of 1.9% to 1.757bn hours. Adjusting those figures for the change in participation, average hours worked per person lifted 0.3% in the month to 139.1 hours, although this is 0.4% below the level from a year ago (139.6 hours). 

For the first time, the Australian Bureau of Statistics (ABS) published monthly estimates of underemployment (those employed but looking to work more hours) and underutilisation (combining the underemployed and unemployed). These figures were previously only available on a quarterly basis. In September, the ABS reported that the underutilisation rate fell 0.2ppt to 13.3%, while the underemployment rate remained at 8.5%. 

The state-level unemployment rates were improved in September, with declines for; New South Wales (-0.25ppt to 4.39%), Victoria (-0.19ppt to 4.55%), Queensland (-0.34ppt to 5.98%), South Australia (-0.2ppt to 5.5%) and Western Australia (-0.37ppt to 6.03%). Tasmania was little changed (-0.02ppt to 5.77%).     

However, outcomes were more varied in terms of employment creation in the month; New South Wales +2,800, Victoria +20,000, Queensland -11,600, South Australia -200, Western Australia +3,100 and Tasmania -1,400. 

For Q3, Australia-wide employment lifted by 45,600, with this outcome dominated by Victoria +48,500 and New South Wales +19,500. A similar concentration is evident over the past 12-months, with national employment growth of +280,900, led by New South Wales +134,200 and Victoria +85,500. Clearly, a more balanced spread of employment growth would be desirable going forward.  

Labour Force Survey — September | Insights   

The overall tone of September's data was positive although, given that the decline in the headline unemployment rate occurred alongside a fall in participation, it remains to be seen whether that 5% rate can hold or be improved upon. Note that the ABS highlighted that 'sample rotation' played its part — the incoming group had lower unemployment and participation rates than the sample.

Given the month-to-month volatility, the Reserve Bank of Australia (RBA) will likely be focusing on the trend unemployment rate, which remains at 5.2% after revision. The RBA, on current forecasts, does not anticipate the unemployment rate declining sustainably to 5% until the end of 2020. Meanwhile, despite some improvement, labour force underutilisation remains elevated, which is reason to think that stronger wages growth is still some way off, particularly given the uneven nature of state employment growth.  

Weekly note (12/10) | Volatile markets catalyst unclear

Global markets endured a highly volatile week, which saw equities marked down heavily as the ongoing trade tensions between the US and China continued to play out. While analysts found it difficult to reach a consensus view over what triggered the declines seen this week, one of the logical conclusions was that equity markets, particularly in the US, having run up strongly over the past couple of years to record levels were now adjusting to rising bond yields.  

Many analysts highlighted the tech-heavy US Nasdaq index, which has risen by around 40% over the past couple of years driven by major companies such as Facebook, Amazon, Apple, Netflix and Google. But, following last week's surge in US bond yields, investors were now forced into a rethink as valuations came under pressure due to heavier discounting, which lowers the present value of future cash flows seeing share prices fall. With investors reconsidering asset allocations, volatility in financial markets increased; the key measure of this, the US VIX, lifted to highs since April.   

Locally, analysts put forward a similar thematic for driving the ASX200 index to its most severe weekly decline (-4.69%) since January 2016. In this context, 'growth' stocks, including the likes of CSL, Cochlear (Healthcare), Macquarie (Financials), A2 Milk (Consumer Staples) and Afterpay (Tech), that have driven gains in the local index were marked down heavily.

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Turning to the macro perspective, the landscape remain broadly unchanged this week, although the International Monetary Fund trimmed its forecasts slightly for global growth for 2018 and 2019; citing risks from escalating trade tensions and the financial stability of emerging markets, which have suffered significant currency devaluations recently, while US President Trump ramped up criticism of the Federal Reserve for increasing interest rates.   

Going back to last Friday, the latest US employment report saw fewer jobs created in September than expected by analysts (+134,000 vs +185,000), but the unemployment rate fell to 3.7% — its lowest since the 1960's. Markets, though, were more focused on the wages component of the data, which showed annual average hourly earnings growth matching expectations at 2.8%. Overall, as shown in the chart, below, with a very tight labour market and wages growth trending higher, US inflation is on the rise and that is likely to keep the Federal Reserve on track for increasing interest rates as signaled over the next couple of years. That path has been more aggressive than perceived by markets so this is, perhaps, another aspect behind this week's volatility on equity markets.

Chart of the Week

In Europe, progress appeared to be made towards the UK and the European Union agreeing to a Brexit deal, with the EU's chief negotiator, Michel Barnier, saying that a deal was within reach over the next week. The two sides moved closer to a key agreement on how to avoid a physical border between Ireland and Northern Ireland, while agreements over trade and security need to be settled before the March 29 split date. Also of note, Italy's budget situation may have taken a turn for the worse, with the government saying that it would not back away from plans to increase its deficit, placing it further at odds with the EU.

Meanwhile, China's central bank, the People's Bank of China, announced at the start of the week a cut to its required reserve ratio of 100 basis points for most of the country's banks. Effectively, the move will free-up banks to release a net amount of 750 billion yuan of liquidity into the Chinese financial system from mid-October, which is targeted at supporting economic growth as the outlook for trade deteriorates following ongoing disputes the US.  

From an Australian perspective, the NAB's Business Survey showed a lift in conditions and confidence in September. Business conditions have been easing over recent months but remain above-average, with the detail pointing to the current pace of employment growth being maintained over the coming months. 

Meanwhile, Westpac's measure of Australian consumer sentiment held in positive territory in October, despite households facing a range of headwinds. There were, however, indications that falling property prices are weighing on consumers, with sentiment towards the property market and expectations for prices deteriorating further in the month. This is in line with the latest Housing Finance data, which softened further in August.

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Global Scorecard: Week ending 12/10/18 

Australian housing finance slides further in August

Australian housing finance data weakened further in August, as the broader themes of tighter lending standards and declining property prices continue to play out. 

Housing Finance — August | By the numbers  

• New Housing Finance Approvals (by number) to owner-occupiers fell by 2.1% in August, which was more severe than the 1% decline forecast by analysts. Approvals from July were revised down from growth of 0.4% to a flat outcome. Approvals are now tracking 10.2% lower through the year, compared to -6.4% last month.  

• By value, total lending commitments (ex-refinancing) fell by 2.7% in August to $A24.223bn, which is a sharp contraction of 13.6% in annual terms.

*Click charts for full-sized images

Housing Finance — August | The details

Looking across the detail, the overall decline in 'new' housing finance — excluding re-financing commitments — of 2.7% was mainly driven by weakness from owner-occupiers, where lending fell by 3.9% in August. Annually, lending to the segment fell by 7.9% — a notable deceleration from last month where the decline was 2.9%. 

For the investor segment, lending fell for the 6th consecutive month in August, this time by 1.1%, with the value of commitments falling 20.5% below the level from a year ago.     

Meanwhile, lending advanced to first home buyers also eased in August, with a 1.1% decline to be broadly flat across the year (-0.5%). Overall, activity in the segment appears to be moderating after a lift over the back-half of last year that was driven by government assistance measures in New South Wales and Victoria.    

The value of refinancing commitments was little changed over the month at $6.444bn, with annual growth of 6.2%.  

Construction-related finance approvals showed further slowing in August, which is not unexpected given the slowing in building approvals and activity data. Approvals for newly constructed dwellings were little changed in the month but are down 15.5% on the year. Meanwhile, the number of approvals to finance the construction of dwellings fell 6.2% for the month and the annual decline slowed from 7.7% to 13%, reflective of a weakening environment for pre-sales. 

Looking across the states, declining finance approvals for owner-occupiers were broad-based in August, with; New South Wales -1% (-13%Y/Y), Victoria -3% (-5.5%Y/Y), Queensland -4.8% (-10.3%Y/Y), Western Australia -0.3% (-18.9%Y/Y) and Tasmania -2.2% (+1.1%Y/Y). South Australia was the only state to see an increase, rising by 1.9% in August but are 2.9% down on the year. 

Housing Finance — August | Insights 

Overall, August's data was weaker than expected, but that is unlikely to be viewed as a surprise by policymakers and markets given the softness evident in other housing-related indicators, such as; property prices — both on the ABS' measure and CoreLogic's Home Value Index — auction clearances, building approvals and construction activity. As the tightening in lending standards continues to play out — logically resulting in restricting housing finance demand, as intended by regulators —  further softening in property prices appears likely given the prevailing mix of conditions. 

Australian retail sales lift modestly in August

Today's keenly anticipated report on Australian retail sales matched expectations for a modest rise in August. Household consumption drove economic growth in the June quarter but turnover growth is tracking at a slower pace so far in Q3 as income growth remains subdued and property prices soften. 

Retail Trade — August | By the numbers  

• Retail sales in August increased by 0.3% to $26.867bn, which was in line with the market forecast (prior 0.0%m/m). 

• Annual growth increased to 3.8% from 2.8%, although that was driven by a base effect after retail sales hit a weak spot in Q3 last year.   

*Click on the charts to zoom

Retail Trade — August | The details 

Despite the headwinds faced by households from  slow income growth and declining property prices, August's report was encouraging as it showed that the discretionary areas drove the headline increase of 0.3%. 

Food retailing — the largest component of retail turnover at around 41% — was flat in August. Excluding the food category, turnover growth was 0.5% for the month. 

The granular detail in August, shown in the chart, below, was; food 0.0% (4.3%Y/Y), household goods 0.2% (2.2%Y/Y), clothing and footwear 0.8% (4.0%Y/Y), department stores 0.9% (2.0%Y/Y), other 0.4%m/m (3.4%) and cafes and restaurants 0.7% (5.0%Y/Y)  

Helping to strengthen discretionary consumption, spending in cafes and restaurants and takeaway food has been lifting over recent months. Annual growth is now at 5%, which compares to the average of 2.9% since August 2017.

Turnover growth across clothing and footwear and department stores remains subdued but looks to be improving gently. 

The household goods category, which includes items such as furniture, electrical goods and hardware, and gardening supplies, is often viewed as a proxy for residential property market conditions. Turnover growth in household goods has been subdued over the past year or so fitting with CoreLogic's Home Value Index, which earlier this week showed national property prices declined for the 12th straight month in September.  

On a state-by-state basis, turnover growth in August was strongest in South Australia (0.8%), followed by Tasmania (0.6%) and New South Wales (0.5%). Subdued outcomes were recorded in Victoria (0.2%), Queensland (0.1%) and Western Australia (flat). 

Annual growth is now fastest in Tasmania (6.2%) — its best result in nearly 4-years — while conditions remain strong in Victoria (5.9%), which continues to drive national retail spending.     

The ABS also reported that online retail spending increased by 4.4% in August, and by 28.8% over the past 12-months. Accordingly, the ABS estimates that the online space accounted for 5.6% of total retail spending in August, which is 1ppt above where it was a year ago.  

Retail Trade — August | Insights

Overall, August's report was a modest result; sales growth of 0.3% for the month was in line with the average for 2018. An improving labour market and strong population growth are factors supporting retail spending, although there are ongoing headwinds from declining property prices and persistently slow income growth, while household saving is at a very low 1% giving reason for caution on the outlook. 

Australian trade surplus holds strong in August

Australia recorded its 8th consecutive monthly trade surplus in August, with the result also exceeding the market forecast. The trade surpluses from July and August are tracking above the level from the 2nd quarter where international trade contributed modestly to economic activity.   

International Trade — August | By the numbers 

• Trade surplus in August was $A1.604bn, which was stronger than the market forecast for a surplus of $1.45bn. July's trade surplus was lowered slightly from the initial estimate of $1.551bn to $1.548bn

• The change in the monthly trade balance was +$56m (prior -$571m)

• Export credits increased by 0.5%m/m to $A36.562bn, with annual growth increasing to 15.3%

• Import debits increased by 0.4%m/m to $A34.958bn, which is 12% higher than a year ago

International Trade — August | The details

Looking at the details, Australia's export earnings increased by $185m, or 0.5%, in August to $36.562bn. Within this; non-monetary gold contributed $228m, rural goods (meat, cereal, and wool) $134m and services $45m however, non-rural goods fell by $222m. 

The decline from non-rural goods was impacted mostly by weakness from iron-ore and coal, which looks to be influenced by lower volumes, although this was moderated by a strong increase from 'other mineral fuels' of $166m, which is supported by LNG exports, and 'other non-rural' (sugar, honey and beverages etc) rising by $151m. 

Earnings from services exports lifted by $45m in August to $7.611bn, with tourism contributing $28m towards the overall increase.

Australia's import bill increased by $130m in August to $34.958bn, which represented a lift of 0.4%. In line with business investment trending up, imported capital goods have been rising — the increase in August was 9% ($569m), although that was impacted by a sharp increase in civil aircraft. Consumption goods imports also lifted modestly, rising by $32m in August. Those gains were moderated by a $264m decline in intermediate goods, which was led by fuels and lubricants.   

Meanwhile, services imports rose by $83m to $8.094bn on the back of an $81m increase in tourism-related services, which includes business, education-related and personal travel. 

International Trade — August | Insights

August's trade surplus was another strong result. Averaging the past 2-months, the trade surplus is around $1.58bn and is tracking ahead of Q2's average of $1.28bn. This is reflective of stronger prices for key commodities, but this is moderated by some softness in export volumes of iron-ore and coal. International trade added 0.1ppt to GDP growth in Q2 and at this stage, another broadly flat result appears likely for Q3, with some risk of a subtraction.  

Australian building approvals slow sharply in August

Slowing Australian building approvals accelerated in August following a sharp decline in unit approvals according to data released by the ABS today. 

Building Approvals — August | By the numbers 

• Total Dwelling Approvals (all sectors) fell -9.4%m/m to 16,477 (seasonally adjusted) in stark contrast to the market forecast for a rise of +1%.  July’s decline initially reported at -5.2%m/m was upgraded to -4.6% on revision.

• House Approvals fell -1.7% to 9,664, which follows a -2.6% decline in July.

• Unit Approvals declined sharply by -18.4% to 6,813. Last month’s decline was -7%. 

Building Approvals — August | The details

The headline fall of 9.4% in August was particularly sharp and was the most severe monthly contraction since December last year. While the seasonally adjusted data are highly volatile month-to-month, the trend series has now declined for 9 consecutive months, after recording a further 1.9% fall in August. Through the year, building approvals have declined by 13.6% and are 9.1% lower in trend terms. The slowdown is being driven mostly by weakening unit approvals, although house approvals have also softened recently. 

For unit approvals, the sharp fall in August (-18.4%m/m) was mainly due to weakness from the high-rise segment in Sydney and Melbourne. For houses (-1.7%m/m), approvals declined in New South Wales (-3.7%), Queensland (-6.1%) and Western Australia (-0.9%). The breakdown of the state detail is shown in the table, below.   

State	August (m/m)	Annual (Y/Y)
NSW	-2.7%	-12.8%
VIC	-12.0%	-17.3%
QLD	-8.4%	-16.1%
SA	+9.6%	-4.6%
WA	+14.7%	+7.0%
TAS	-18.6%	4.9%
AUS	-9.4%	-13.6%

Based on ABS 8,731.0

The ABS also reported that the value of non-residential building approved fell 24.5% in August, while the value of alterations and additions fell 3.3%m/m.   

Building Approvals — August | Insights

Momentum in building approvals continues to ease, which matches with the broader context of declining property prices and tightening credit conditions. While population growth remains strong, particularly in New South Wales and Victoria, the pipeline of projects is being worked through after the upswing in activity over the past few years. This points to a forthcoming softening in residential construction activity, which saw a strong first half of 2018 contributing 0.3ppt to GDP growth